The U.S. economy is still reeling from the effects of the 2007-2008 collapse of the housing market. European economies, including those of Spain and the UK, were also hard hit from the same housing bubble syndrome. Back in the early nineties, Japan’s economy, then the fastest growing major economy in the world, suffered a similar collapse, one from which it has yet to completely recover.

Chinese real estate is the latest housing bubble candidate some prominent international investors have been warning, the bursting of which would dwarf all those that occurred previously. Will excessive debt creation, leverage and rampant real estate development and speculation derail the Chinese economic miracle?

How the Chinese Housing Market Became a Bubble

Growing at double digit rates since the late eighties, China has emerged as global economic power. While manufactured exports have been the engine for China amassing over $2 trillion in foreign exchange reserves, Chinese real estate and property development and investment have been the principal outlets for the savings of increasingly affluent, predominantly urban, Chinese.

Yet despite spectacular growth in housing supply, owning their own home remains increasingly out of reach for the vast majority of Chinese. Rampant real estate development and speculation have led to the building of entire “ghost cities” that are nearly, if not completely, vacant. As many as 64 million Chinese apartments are vacant, according to some estimates.

Feverish speculation has led nationwide housing prices to rise an estimated 140 percent since 2007. Housing prices in Beijing have risen as much as 800 percent in the past eight years. This in turn has led the Chinese government to impose stricter bank reserve requirements and mortgage lending practices, as well as raise base lending rates in an effort to dampen the feverish mood of development and speculation.
Yet local governments continue to rely on land sales for revenue, and Chinese real estate and property developers have amassed enough wealth to make them a powerful lobbying group both at local and national levels of government.

China’s banks continue to rely on commercial and residential real estate development loans to drive revenue and profit growth. If those loans were to turn sour and banks were compelled or required to price those assets to market or write them off, much of the Chinese banking system would be in ruins.

Repercussions of a Burst

Bailing out the banks, as happened in the U.S., would likely leave depositors and individual mortgage owners, or the Chinese government in their stead, holding the bag. That would only add fuel to broad public discontent. That’s a doomsday scenario that Chinese government officials want to avoid at all costs. The high cost of housing and increasingly wide and apparent disparities in wealth have already led to civil unrest.

“Even as these apartments go empty, gathering dust waiting for renters who never come, poor Chinese laborers are living in epically crowded conditions. For all of China’s phantom real estate, there are multiple families sharing tiny domiciles, with as many as 11 in a two-bedroom apartment,” wrote Justice Litle, editor of the Taipan Publishing Group, in a July editorial.

“It doesn’t make sense. With so many residences barren and empty, why is the Chinese labor class packed in like human sardines? Because the shiny new apartments are far too expensive for the average Chinese worker to afford–orders of magnitude more than the average salary, with very strict payment terms (50% up front, 36 months for the rest).” Sound at all familiar?

Prominent international investors, hedge fund Kynikos Associates’ president Jim Chanos prominent among them, likewise continue to warn that China’s housing market is likely to turn out to be the mother of all asset bubbles.

“What we define as a bubble is any kind of debt-fueled asset inflation where the cash flow generated by the asset itself–a rental property, office building, condo–does not cover the debt incurred to buy the asset,” Chanos told Charlie Rose in an April 2010 interview. “So you depend on a greater fool, if you will, to come in and buy at a higher price. We’re seeing behavior [we saw] in 2005 in Miami or ’06 or ’07 in Dubai.”

Will the China Bubble Break Just Like the U.S.?

Will the Chinese housing market implode just as the U.S., European and Dubai markets did before them? Or will China’s policy makers and real estate industry professionals be able to avoid the pitfalls that threaten to derail China’s economic miracle? Chanos continues to put the odds in favor of the first.

“Let’s be clear: What we’re talking about is a world-class–if not the world-class–property bubble,” Chanos said. “The fact is the game has to keep going. They’re on this treadmill to hell because 50% to 60% of GDP is construction. And if they stop construction, you’ll see GDP growth go negative quickly,” he explained.

“That’s not going to happen because in China, people are rewarded at almost every level of government for making their economic growth numbers. The easiest way to do this: put up another building. So they’re really hooked on this sort of heroin of real estate development.”

All that said, given China’s size and its centralized command-and-control economy, it could be quite some time before Chanos and other China bubble bears see their predictions become reality. And waiting for a collapse could prove very costly for short-sellers.

Andrew Burger reports on financial markets, investments and the economy. He has an MBA in finance and several years’ experience working in the wholesale money, debt and derivatives markets.